Banking Interpretations

NYSBL 98

To: Senior Bank Examiner Qiu
From: Assistant Counsel Sullivan
Date:

September 27, 2010
Subject: [---] (the “Bank”) –
 

Real Estate Acquired in Satisfaction of Debt Previously Contracted (“DPC Real Estate”)

 

Issue:

Whether the Bank must obtain the approval of the Banking Department in order to hold certain DPC Real Estate for longer than five years from its acquisition?

Answer:

No.  There is no requirement to obtain such approval. 

However, the Bank will have to dispose of the DPC Real Estate within ten years of its acquisition unless the Bank:

  1. Holds such DPC Real Estate through a subsidiary in which it holds a majority of the voting shares, and
  2. Obtains the written consent of the Federal Deposit Insurance Corporation (the “FDIC”) allowing the Bank to hold such DPC Real Estate for a longer period.  

Facts:

The Bank acquired a parcel of real estate by foreclosure on September 16, 2004.  The property had been mortgaged to the Bank to secure a small business loan.  The Bank has incurred difficulty in disposing of the property.  The Bank has requested by letter that it “be permitted up to ten years from acquisition of the real estate to complete divestiture”.1  The letter cited a requirement in Regulation Y – specifically, 12 C.F.R §225.140(d). 

Discussion:

Requirement under New York law:

A New York or a national bank is permitted to acquire in satisfaction of debt previously contracted property that it would not otherwise have the authority to acquire and hold ("DPC Property".)2  Either type of bank must dispose of such DPC Property within a reasonable time and must not use this authority to hold the DPC Property for investment purposes.  The reason for a bank's "salvage power" to acquire DPC Property is to facilitate a bank's recovery on troubled debt and not to provide the bank with a method to circumvent the restrictions on what would otherwise be prohibited investments.3

Section 98.1(b) of the Banking Law specifically permits a New York chartered-bank to hold DPC Property that consists of interests in real estate.4  Separately, Section 98.1(c) allows such a bank to hold real estate acquired in a judicial sale where that bank held a mortgage in the property (real property acquired under either Section 98.1(b) or (c) being “DPC Real Estate”.)  Since 1984, New York law has imposed no specific time limits on the period within which a New York bank may hold DPC Real Estate.5

Requirement under Federal law:

In contrast, Section 29 of the National Bank Act6 requires that a national bank obtain the approval of the Office of the Comptroller of the Currency to hold DPC Real Estate more than five years and that the bank, in any event, divest itself of DPC Real Estate within an outside limit of ten years. 

Section 24 of the Federal Deposit Insurance Act (“FDIA”)7 generally limits an insured state bank to making equity investments of a type that could be made by a national bank.  Section 24 also prohibits a state bank from engaging as principal, either directly or indirectly through a subsidiary, in an activity not permissible for a national bank unless the state bank is at least adequately capitalized and the FDIC determines that the activity will pose no significant risk to the deposit insurance fund.

The regulations that implement Section 24 for state insured banks are set forth in 12 C.F.R. Part 362.  Section 362.1(b) excludes from the application of Part 362, and thereby from the restrictions of Section 24, DPC Property provided that:

“the insured State bank does not hold the property for speculation and takes only such actions as would be permissible for a national bank's DPC [Property].  The bank must dispose of the property within the shorter of the period set by Federal law for national banks or the period allowed under State law.  For real estate, national banks may not hold DPC [Property] for more than 10 years.”

This means that if the DPC Real Estate were held directly by the Bank for more than ten years, it would become an “equity investment of a type that is not permissible for a national bank,” and therefore, would be prohibited by Section 24(c) of the FDIA.

On the other hand, if the DPC Property were held for more than ten years by a subsidiary of the Bank8 such subsidiary would be engaging as principal in an activity not permissible for a national bank.  Section 24(d) of the FDIA would prohibit the subsidiary’s so engaging in such activity unless the Bank remained at least adequately capitalized and the FDIC determined that the activity would pose no significant risk to the deposit insurance fund.9

Bank Holding Company Act:

In requesting that the divesture period be extended, the Bank cited a provision in Regulation Y promulgated under Section 4 of the Bank Holding Company Act (“BHCA”) – i.e., 12 C.F.R §225.140(d).  However, that section applies to nonbank subsidiaries of bank holding companies. 

The restrictions on nonbanking activities in Section 4 of the BHCA do not apply to the direct activities of banks even if such banks are subsidiaries of bank holding companies.10  Indeed, even if the DPC Real Estate were held in a subsidiary of the Bank in which it held a majority of the voting shares, such restrictions would still not apply.11

 Noted: M.E.G.

_____________________

The Memorandum of the Banking Department on the Omnibus Banking Act indicated that the repeal of Section 98.3 would permit a New York bank “to perpetually retain“ such DPC Real Estate.  The use of the phrase “perpetually retain” appears to have been overly expansive in light of the rationale for allowing a bank to hold DPC Property.

  1. [---]
  2. Such DPC Property may include interests in real estate or equity securities.
  3. A New York bank may acquire and hold DPC Property if such action represents a reasonable and appropriate effort to collect indebtedness under its ability to "exercise all such incidental powers as shall be necessary to carry on a banking business," New York Banking Law §96.  In interpreting the National Bank Act, courts have consistently held that similar language –"exercise . . . all such incidental powers as shall be necessary to carry on the business of banking", 12 U.S.C. §24(Seventh) – includes the power to acquire DPC Property if necessary to salvage a loan. E.g., First Nat'l Bank of Charlotte v. Nat'l Exch. Bank of Baltimore, 92 U.S. 122, 128 (1875); Atherton v, Anderson, 86 F.2d 518, 525-26 (6th Cir. 1936), rev'd on other grounds, 302 U.S. 643 (1937).
  4. Section 97.4-c contains an analogous provision that allows a New York chartered-bank to hold DPC property that consists of stock or other equity interests.
  5. Prior to the Omnibus Banking Act of 1984, Laws 1984, Chap. 360, a New York bank had to divest itself of DPC Real Estate within five years unless the Superintendent, upon formal application from the bank’s board of directors, extended such time limit. Banking Law §98.3 (repealed 1984).
  6. 12 U.S.C. § 29.
  7. 12 U.S.C. § 1831a.
  8. The Bank could establish a majority-owned subsidiary for such purpose under Section 97.4-a(d) of the Banking Law and Part 14 of the General Regulations of the Banking Board.
  9. To seek such a determination, the Bank would apply to the FDIC under its regulations that are set forth at 12 C.F.R §303.120 et seq.
  10. Merchants Nat’l Corp., 72 Fed. Res. Bull. 876, 881 (1987), rev’d on other grounds sub nom. Independent Ins. Agents of America v. Board of Governors of the Fed Reserve Sys., 838 F.2d 627 (2d Cir. 1988).
  11. 12 C.F.R. §225.22(e)(2).  Letter dated August 16, 2000 from Jennifer J. Johnson, Secretary of the Board of Governors of the Federal Reserve System, to Ronald C. Mayer, Senior Vice President and Associate General Counsel of The Chase Manhattan Bank, available at: http://www.federalreserve.gov/boarddocs/legalint/BHC_ChangeInControl/2000/20000816/